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Types and consequences of indirect clearing arrangements for CCP-cleared OTC emissions trades under EMIR - Page 2
Thursday, 05 July 2012 06:40


Indirect clearing arrangements


Given the above-signalled current and near-future regulatory environment it’s time for emission traders to prepare for clearing with the CCP of the OTC trades (when it is required pursuant to EMIR – see in particular Clearing thresholds calculating under EMIR draft Regulation and ESMA Draft Technical Standards).


Among the potential practical implications there will be the review of existing documentation (procedures and contracts) as well as clearing documentation. It will be necessary to spend time and costs in determining which CCP to use. Adapting to  future changes will also require examining fees for clearing services CCPs are likely to charge as well as fees clearing members are likely to charge for services provided by them to client firms.


The strategic choices to be made are also as regards direct or indirect clearing arrangements for CCP services. It is useful to make this particular assessment bearing in mind the clarifications given by the European Securities and Markets Authority (ESMA) in Consultation Paper for Draft Technical Standards for the Regulation on OTC Derivatives, CCPs and Trade Repositories of 25 June 2012 (available on ESMA’s website).


The starting point is that in order to comply with the clearing obligation, a counterparty must become a clearing member, a client or establish indirect clearing arrangements.


According to ESMA, these indirect clearing arrangements cannot increase counterparty risk and have to ensure that the assets and positions of a counterparty entering into an indirect clearing arrangement benefit from protections with equivalent effect to those allowing segregation and portability for direct clients.


According to the EMIR mandate, ESMA is currently required to draft Regulatory Technical Standards (RTS) specifying the types of indirect contractual arrangements that meet the conditions mentioned above.


Existing confusion over the precise definition of an indirect clearing arrangement, including whether it encompasses traditional client relationships with CCP clearing members, is also acknowledged by ESMA in the above Consultation Paper.


ESMA in the said document clarified that arrangements allowing for the clearing of transactions of indirect clients mean the clients of clients of clearing members.


These indirect client arrangements being relatively a new concept, are, however, not uncommon in the EU and have been adopted by some smaller institutions e.g. in order to access third country CCPs. Indirect clearing arrangements are also included in EMIR.


As ESMA underlines, regulatory standards should establish minimum requirements for indirect clearing arrangements that adequately protect the assets and positions of indirect clients from default further up the transaction chain.


There was no consistent view on whether indirect clients’ assets and positions should be held with the CCP or the clearing member, but most respondents noted the importance of ensuring that indirect clients have the option of individually segregated accounts, at least with the clearing member. A small number of respondents highlighted possible tensions between requirements on the portability of indirect clients’ assets/positions and insolvency law. Finally, a number of responses highlight the importance of adequate disclosure.


On the basis of the above feed-back, ESMA considers that it is appropriate to clarify the concept of indirect clearing arrangements. In this respect, recital 33 of EMIR clearly suggests that the legislators consider this arrangement as being different from a clearing member to client relationship, thus implying that indirect clearing arrangements are client-to-client arrangements, i.e. the situation where a client of a clearing member is providing clearing services to its clients. Therefore a direct client is considered a client that has an account with a clearing member, while an indirect client is considered a client of a client.


It should be noted that the fact that indirect clients should have an equivalent level of protection as direct clients does not necessarily mean that indirect clients should have exactly the same rights as direct clients and that the same structure and options for accounts held at a CCP level should be available to indirect clients.


In ESMA’s view, an ‘equivalent’ level of protection means that the indirect client should be protected from the default of the direct client providing clearing services and from any losses resulting from the default of other direct clients of the same clearing member, but it does not mean that the same structure envisaged for a CCP to clearing member to client relationship is available also to indirect clients. Instead, that structure should be replicated for indirect clients one step lower, i.e. at the level of the clearing member instead of at the level of the CCP.


To ensure that the positions of indirect clients are protected in an equivalent manner as direct clients, ESMA considers that an indirect client should have the possibility of requesting an individual client account with the clearing member, but not necessarily with the CCP.


In the Consultation Paper it is also considered that:


a. The direct client providing clearing services should at least maintain an individual client account at the CCP level for the exclusive purpose of holding assets and positions of indirect clients. This means that for its proprietary positions the direct client will retain the right to choose between omnibus or individual segregated accounts, but for the indirect clients it will need to maintain at least one specific segregated account at CCP level. This will ensure that the indirect clients are not exposed to losses derived from the proprietary positions of the direct client and that indirect clients are not exposed to losses deriving from other clients of the clearing member.


b. If the direct client defaults, the clearing member must have procedures that ensure the transfer of the indirect client positions to another client or commit to directly manage these positions. In order to ensure portability, the clearing member would need to know the identity of the indirect clients. However, this is considered commercially sensitive information for the direct client. For this purpose, appropriate Chinese walls should be established by the clearing member to ensure that the information provided by the direct client to the clearing member to enable the latter to properly manage the counterparty credit risk arising from indirect client arrangements is not used for commercial purposes.


Furthermore, it is expected that all information held by a client in respect of its indirect clients will be made available to the clearing member following the default of the direct client.


ESMA also considers that there should be full transparency over the different types of account segregation available to indirect clients and the level of protection provided by each option.


It seems to be undisputable, the above ESMA clarifications may contribute to greater transparency of indirect clearing arrangements, and, thereby, offer some help for market participants, particularly in the perspective of imminent EMIR implementation.






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